Terry Smith has warned investors they risk forgoing gains if they shun growth stocks in favour of value on the back of spurious bear market predictions.
In his annual letter to Fundsmith Equity investors, Smith said many advisers and commentators have predicted crashes and bear markets leading investors to take preventative action such as rotating into value stocks, holding cash and even buying bitcoin.
But he said no one can predict market downturns with any useful level of reliability and he discounted the recent bout of volatility, saying it was over exaggerated by the media.
“The MSCI World Index (£ net) fell by 5.4% in October and after a rally this was followed by a fall of 7.4% in December. Despite the hysterical headlines this, in my opinion, falls well short of turmoil — a word frequently used to describe these events.
“An example of what might reasonably be described as market turmoil was so-called Black Monday 19 October 1987 when the Dow Jones Industrial Average Index fell 22.6% in a single day.”
Not a clear bear market
Smith said the best time to rotate into value stocks is after the bear market has struck and it is not yet clear that the market is in bear territory.
Furthermore, most stocks are not currently at valuations which would attract classic value investors.
“If you approached any of the famous value investors and suggested they buy some of the assorted value stocks in the FTSE 100 index as a value play, I think they would just laugh at you,” he said.
He noted a value stock like Imperial Brands was on an historic P/E of 8.1x at the end of 2000 in a bear market. It is now on an historic P/E of 16.5x.
“An aim for a value investor might be to buy ‘value’ stocks in a downturn when their yield is higher than the P/E,” he added.
Smith said value investing has been out of fashion in recent years as low interest rates have driven the value of almost all stocks beyond the reach of true value investors. But he said it will have its day when stocks of the sort which attract value investors perform well.
Weakest absolute returns since inception
Elsewhere, Smith noted the fund’s returns in 2018 were its weakest in absolute terms since inception but this needed to be considered against other funds in the sector and the benchmark.
The fund returned 2.2% in 2018 versus the MSCI World’s -3.04%, the FTSE 100’s -8.73% and FTSE All Share’s -9.47%. In 2017 the fund produced a total return of 21.97%, according to FE Analytics.
He added: “A bear market will occur at some point. We may indeed already be in one. The best stance is to ignore it since you can’t predict it or position yourself effectively to avoid it without impoverishing yourself by forgoing gains.”
Fundsmith Equity versus indices and sector
| Index/sector | Total return 1 Jan ’18 – 31 Dec ’18 (£) |
| FTSE 100 | -8.73% |
| FTSE All Share | -9.47% |
| Fundsmith Equity T Acc | 2.20% |
| IA Global | -5.72% |
| MSCI World | -3.04% |
Source: FE Analytics
